ECON 203_CHAPTER_V

Question 1

Production stages

Answer 1

Production occurs in stages: some firms produce outputs that are used as inputs by other firms, and these other firms, in turn, produce outputs that are used as inputs by yet other firms.

Question 2

Double/multiple counting

Answer 2

Double/multiple counting is the error that would arise in estimating the nation’s output by adding all sales of all firms

Question 3

Intermediate goods

Answer 3

Intermediate goods are all outputs that are used as inputs by other produces in a further stage of production

Question 4

Final goods

Answer 4

Final goods are products that are not used as inputs by other firms but are produced to be sold for consumption, investment, government, or export during the period under consideration

Question 5

Distinguishing intermediate and final goods

Answer 5

It is difficult to distinguish intermediate and final goods because firms do not know if their sale is going to be finished by the buyer, or sold again.

Question 6

Value added

Answer 6

Value added is the value of a firm’s output (sales revenue) - inputs/cost/purchases of intermediate goods (other firms’ goods)
AND Value added = payments owed to the firm’s factors of production
Payments made to factors of production such as wages to workers or profits to owners are not purchases from other firms and hence cannot be subtracted from the firm’s revenue, but since the firm’s revenue must be fully exhausted by the cost of intermediate goods plus all payments to factors of production, it followers that value added is exactly equal to the sum of these factor payments.
Value added is the correct measure of each firm’s contribution to total output–the amount of market value that is produced by that firm and its workers.
The sum of all values added in an economy is a measure of the economy’s total output

Question 7

Value of domestic output

Answer 7

The value of domestic output is equal to the value of the expenditure on that output and is also equal to the total income generated by producing that output

Question 8

The Circular Flow of Income & Expenditure

Answer 8

Look at diagram, national income is equal to national product–shown by the circular flow of income and expenditure.

Orange is simple circular flow
Blue is injections (exports, investment, government purchases)
Green is withdrawals from the circular flow (imports, savings, taxes)

Question 9

Examples of the circular flow of income & expenditure

Answer 9

Your father buys a car: simple circular flow
A Canadian company exports medicine to Mexico: Injection
You put 500$ into your TFSA: withdrawal
Your neighbour invested in the stock market: withdrawal
You got paid for your work at the restaurant: simple circular flow
QC gov builds a new school: injection
American farmers sell wheat to Canada: withdrawal
You paid income taxes: withdrawal

Question 10

GDP on the expenditure side

Answer 10

GDP on the expenditure side is when you add up the expenditures needed to purchase the output produced in that year. Total expenditure on output is the sum of consumption, investment, government purchases, net exports
These 4 categories are exhaustive, they are defined in such a way that all expenditure falls into one of the four categories

GDP = Ca + Ia (gross investment, we are still producing) + Ga + NXa

Question 11

Consumption expenditure

Answer 11

Consumption expenditure (C) is expenditure on all goods and services for final use (households/businesses)–i.e. Haircuts, legal advice, vegetables, clothing, etc.–Actual measured consumption expenditure is denoted by Ga

Question 12

Investment Expenditure

Answer 12

Investment expenditure (I) is expenditure on the production of goods not for present consumption i.e. inventories of goods made, but not yet sold & inputs purchased but not yet used in production (factories, computers, machines, warehouses, residential housing)

Question 13

Investment Expenditure: Changes in inventories within investment expenditure

Answer 13

Inventories are stocks of raw material, goods in process, and finished goods held by firms.
Inventories of inputs & unfinished materials allow firms to maintain production despite interruptions with deliveries of inputs from other firms
Inventories of outputs allow firms to meet orders despite fluctuations in production

Question 14

Investment Expenditure: Accumulation of inventories

Answer 14

Accumulation of inventories counts as positive investments since it represents goods produced but not used for current consumption–included in national income accounts at their current market value

Question 15

Investment Expenditure: Decumulation of Inventories

Answer 15

Decumulation of inventories is the drawing down of inventories, it is disinvestment (negative investment), since it is a reduction in the stock of finished goods available to be sold

Question 16

Investment Expenditure: New plant and equipment/capital stock

Answer 16

New plant and equipment/capital stock is total capital goods (manufactured aids to production i.e. machines, buildings)
Adding to the existing stock of capital goods is an act of investment–business fixed investment or fixed investment

Question 17

Investment Expenditure: New Residential Housing

Answer 17

New residential housing is a house/apt building that yields its utility over a long period of time.
It counts as an investment expenditure rather than consumption expenditure.
When an individual purchases an existing house, ownership is transferred–transaction is not part of national income. Only when a new house is built it counts as a residential investment in national accounts.

Question 18

Investment Expenditure: Total Investment

Answer 18

Total amount of investment is the sum of changes in inventories, the additions to the stock of plant and equipment, and the new construction of residential housing units–actual total investment expenditure is Ia
Some of the investment occurring during a year is used to replace some physical capital that wears out through use in a process called depreciation, but all of the investment whether for replacement or for expansion of the capital stock represents expenditures. And all of the investment generates income, so all GDP

Question 19

Government purchases (G)

Answer 19

All government expenditure on currently produced goods and services, exclusive of government transfer payments–actual government purchases of goods and services are denoted as Ga
Government output is valued at cost and not market value

Question 20

Government purchases vs government expenditure

Answer 20

Only when government purchases of currently produced goods and services are included as part of GDP–a pension plan, unemployment insurance, welfare, interest on national debt (which transfers income from taxpayers to holders of government bonds) payment is no market transaction

Question 21

Transfer payments

Answer 21

Transfer payments are payments to an individual or institution not made in exchange for a good or service–not included in expenditure on a nation’s total output and are therefore not included in GDP

Question 22

Net exports

Answer 22

Net exports are exports (foreign expenditure on domestically produced goods and services)-imports (domestic expenditure on foreign-produced goods and services)

Question 23

Exports

Answer 23

Goods/services sold to foreigners are Canadian production and income, so not included in Ca Ia Ga

Question 24

GDP on the income side

Answer 24

GDP on the income side is when you add up the total flow of income (factor incomes and value of output) generated by domestic production and is equal to that value of production
Labour must be hired and paid, land must be rented, capital must be purchased or rented

Question 25

Factor incomes

Answer 25

Factor incomes consist of wages, salaries, interest, and business profits (it also includes rent received by property owners)

Question 26

Interest on the income side of GDP

Answer 26

Interest includes bank deposits, loans, miscellaneous other investment incomes. NOT INCLUDE LOANS ON CANADIAN GOVERNMENTS

Question 27

Factor Incomes: Business Profits

Answer 27

Business profits can be dividends to owners of firms, the rest are held by firms called retained earnings
Total profits include corporate profits government business enterprises, crown corporations i.e. Canada Post and Hydro-Quebec, incomes of unincorporated businesses (small business, farmers, partnerships and professionals), rent paid on land and buildings
Profits and interest together represent the use of capital–interest for borrowed capital and profits for capital contributed by owners of firms

Question 28

Factor Incomes: Net Domestic Income

Answer 28

Net domestic income at factor cost is the sum of wages, salaries, interest and profits
Net since it excluded the value of output that is used as replacement investment

Question 29

Non-factor Payments

Answer 29

Part of the cost of the item that does not get paid as income to factors of production–due to indirect taxes and depreciation

Question 30

Non-factor Payments: Indirect Taxes and Subsidies

Answer 30

Output comes significantly in indirect taxes (in Canada GST 5%)
Subsidies are negative taxes that needed to be subtracted to total factor income

Question 31

Non-factor Payments: Depreciation

Answer 31

Worn out capital investment, the lost value is not accrue to production, so from the income side GDP is the sum of factor incomes plus indirect taxes–net of subsidies–plus depreciation

Question 32

Arbitrary Decision in National Income Accounting

Answer 32

Finished goods that are held in inventories are valued at market value–anticipating sale
However what if the product is half finished like a house or a novel? They are processed at cost if the goods are made by firms
So GDP can be different if measured with different arbitrary decisions

Question 33

Nominal GDP tells us about the money value output (current prices) real GDP tells us about the quantity of physical output (base-period prices)

Answer 33

yes…again

Question 34

GDP deflator

Answer 34

GDP deflator = GDP at current prices/GDP at base-period prices x 100 = Nominal/Real GDP x 100
GDP deflator is an index number derived by dividing nominal GDP by real GDP–measures average change price of all items in GDP
If nominal and real GDP change by difference over a given time period, then prices must have changed over that period.
Ex: nominal gdp 6% increase, real gdp 4% increase, so average prices must have increased by 2%

Question 35

GDP Deflator vs CPI

Answer 35

GDP deflator does not necessarily change in line with changes in the CPI
Movements in the CPI measure the change in the average price of consumer goods
Movements in GDP deflator reflect the change in the average price of goods produced in Canada
Ex: Price of coffee would have a larger effect on CPI than on the GDP deflator, since Canada drinks a lot of coffee but does not produce it. The opposite can be side about wheat production/consumption (we export a lot of wheat)
So changes in the GDP deflator and CPI similarly reflect over inflationary trends. Changes in relative prices however, may lead the two price indices to move in different ways

Question 36

Omissions (excluded) from GDP

Answer 36

Omissions from gdp depict economic activity takes place outside the markets that the national income accountants survey, even if they don’t measure in the GDP they still use real resources and generate incomes i.e. illegal activities–some do get included in national income but are misclassified by industry (tax evasion)–money laundering

Question 37

GDP Omissions: Underground Economy

Answer 37

The underground economy is when the transaction is legal, but not reported for tax purposes (i.e unreported cash transactions)
The growth comes from the rise of the service industry–it is easier to hide carpentering services as an independent than a manufacturing establishment–estimated at about 2-5% of GDP

Question 38

GDP Omissions: Home Production

Answer 38

If someone were to hire a landscaper to do a service, and they report the income then it enter into GDP, but if homeowner does landscaping themself, then it is omitted from GDP since there is no recorded transaction, but they still use real resources
Ex: cooking, cleaning, shopping, doing laundry–home production

Question 39

GDP Omissions: Volunteer work

Answer 39

Ex: Coaching hockey team, canvassing a political party–they are volunteer work that use real resources and add to economic well-being, but not assessed a market value so non-market activities

Question 40

GDP Omissions: Leisure

Answer 40

Leisure depicts for example if a lawyer chooses to reduce their time at work from 2400 hours to 2200 hours per year, so national income falls by lawyer’s wage rate times 200 hours–but those hours lost through leisure outside of the marketplace presumably exceeds lost wages, so economic well-being increased

Question 41

GDP Omissions: Free Products in the Digital World

Answer 41

Ex: free products such as Internet search engines, social media platforms, online maps–there is no purchase involved but users receive benefits, but the industry is valued at billion of doors

Question 42

Economic Bads

Answer 42

Ex of economic bads: when a power plant burns toxic fumes and leads to acid rain, the value of electricity is sold but the value of the damage done by acid rain is not deducted
Also when cars’ gas (which is used in national income), but the damage caused by greenhouse gases is not deducted
Social media leads to mental health
So economic well-being/consumption is not necessarily good

Question 43

Do the Omissions Matter?

Answer 43

Changing the way we calculate GDP to incorporate the omissions would be difficult but not impossible, but it would be costly
Including economic bads would change the nature of the measurement such that it would no longer give an accurate measure of the level of economic activityty (. ) ( .)
They don’t change measurement bc 1. Difficult 2. The level of measured gdp may be inaccurate, the change in GDP from one year to the next is a good indication of the changes (as long as omissions aren’t changing drastically) 3. Policymakers need to measure the amount of market output in the economy to control inflation and taxes, so it would distort these figures

Question 44

GDP and Living Standards

Answer 44

To what extent does GDP provide a useful measure of our living standards, considering its flaws?
It depends on definition of living standards which usually refers to purchasing power or real income
When GDP rises, we do not necessarily experience a rise in our average real incomes–it would be best measured as real GDP per person which does not necessarily rise when real GDP rises
If real GDP rises bc more ppl are employed, real GDP per person may not rise, but if real GDP rises because existing labour force becomes more productive, then average real income will also rise
But to many ppl living standards is broadening than real per capita income (material standard)–it actually includes religious and political freedom, community life, environmental sustainability, distribution of income, ability to prevent and treat disease
Researches have been developing broad indexes of social well-being like the Human Development Index (HDI)–life expectancy, education, material living standards (Norway ranks highest)
Subjectivity on priorities depending on industry (leisure vs cleaner environment)

Question 45

Does the following affect GDP

Answer 45

A. Daniel has his tooth extracted (at a dentist’s office)–yes, doctor gets paid it is a service
B. Jim rents a one bed-room in NDG–yes it is a housing service
C. Bought a new house in Laval–yes it’s a new domestically produced good
D. Bought a 50-year-old house in NDG–no bc it’s not new, only transferring ownership
E.Hugo deals drugs sells drugs–no bc it’s illegal and an import
F. Bombardier increases production of helicopters are exported to India–yes
G. Canada drinks aussie wine–no (hi Sarah Ronnie)
H. Ford opens a factory in Ontario–yes
I. Kate buys shares of rogers–no nothing new is produced, ownership is transferred
J. Jill buys 500 bonds of suncor energy (standardised loan it makes you a lender)–no bc change of ownership not real investment
K. Steve writes a poem and reads it out loud to his neighbours, no there is no market value
L. Publishing house Read-N-Write publishes Steve’s poem–yes, because now market evaluation
M. Professor Dull teaches two accounting classes at uni–yes, because it is a service
N. You sold an used car to a friend–no because it a resale no new product is produced
O. You assemble IKEA furniture by yourself–no, no market evaluation of the service,
P. You hire someone to assemble IKEA furniture–yes it is a service
Q. Real estate agent receives commission from Ottawa new condo sale–yes it’s a service of sale
R. Kid needs to see doctor–yes because it’s a service

Question 46

From these values: What is the value of the GDP from the expenditure approach? What is the value of the GDP from the income approach?

Wages and salaries 2905
GST remittances 120
Exports 30
Gross investment 530
Depreciation 80
Consumption expenditure 2800
Government subsidies to firms 50
Business profit 410
Imports 35
Interest and investment income 260
Government purchases 400

Answer 46

What is the value of the GDP from the expenditure approach? 3725
Y = C + I + G + Nx
Y = Consumption expenditure 2800 + Gross investment 530 + Government purchases 400 + Exports 30 - Imports 35 = 3725

What is the value of the GDP from the income approach? 3725
Y = Wages and salaries + interest + business profits + taxes + depreciation - subsidies
Y = Wages and salaries 2905 + Interest and investment income 260 + Business profit 410 + GST remittances 120 Gross + Depreciation 80 - Government subsidies to firms 50 = 3725

Question 47

A horse walks into the bar

Answer 47

I want to sleep, the horse should go home too the kids are waiting